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ETF's as a hedging tool?

A while a go I wrote a post that discussed the difference between ETF’s and and Index Funds for diversification purposes … and, you know what I think about diversification.

But, for those who are just passing by the blog and thought you’d like to drop in [AJC: my regular readers will skip over this post because they wouldn’t be interested in diversification either 😉 ] here is an interesting article from the Tycoon Report:

If you haven’t already, you should start moving your money out of mutual funds and into ETFs (Exchange Traded Funds). In my opinion, they are tailor made for the “Average Joe” investor to get the benefits of a mutual fund without their crazy fees.

In my opinion, the only downside (for some people) with respect to ETFs may be that you can buy and sell them as easily as you can. The reason that I say that this may be a downside for some people is because, if you are impatient or have an addictive personality,etc., then you may know yourself well enough to stay away from investments that you can easily get in and out of.

In other words, if your personality is such that you are tempted to trade without a logical reason to do so, then perhaps the difficulties (such as fees) that come with a mutual fund will prevent you from trading needlessly. An ETF, on the other hand, may (because of their ease) encourage certain types of people to trade. If you do not have this type of issue, then you should certainly choose ETFs over mutual funds.

I like ETFs personally because they are less risky than individual stocks. As you may know, you can never totally eliminate risk, but you can reduce it. You can reduce risk by hedging, diversification, and insurance. ETFs reduce risk through diversification, as you’re not assuming the risk that your investment will go to zero based on the demise of one single company.

Nice summary. Here’s where I sit … if you’re using the ETF for:

1. Speculation– Using an ETF (or any other ‘broad-based’ investment) as a hedge against short-term risk is fraught with danger … you are speculating. Yes, you are ‘hedging’ against the risk of any particular stock tanking (conversely, spiking) but you are really just betting with/against the whole market – if people knew where the market was going, they would be richer than Buffett. On the rare occasions that I do speculate (anything less than a 5 – 10 year outlook going in is speculating to me), I prefer to speculate with options and/or just a select handfull of the underlying stocks.

2. Investment– Now, if I am going to invest with a 5 – 10+ year outlook going in, then I am less likely to be speculating and more likely to be ‘saving’ or ‘investing’. It’s important to realize that I may not actually hold the investment for that long ( who knows what the future will bring?), but I certainly have the expectation of holding, going in. I don’t like to ‘invest’ in a broad-based ETF/Index because then I am truly ‘investing’ in paper, and market sentiment/emotions. I would not be investing with the understanding of the fundamentals of the underlying business, which is the only way that I expect to ‘beat the market’ in the long-term: buy under-valued businesses that I would be prepared to hold forever, and wait for the market to ‘catch up’ to my way of thinking … this is pretty much what Buffett does (actually, did … when he was a little smaller and could make smaller investments) with the stock investment part of his portfolio. If I get it wrong, but I llike the business and it makes good profits (else, I wouldn’t have bought it … then, I don’t mind holding. If I get it right, and the price spikes up to ‘fair market value’, I may end up selling early.

3. Saving– I don’t have ‘saving’ strategies – my speculation (20%) and investment (80%) strategies seem to cover me pretty well. But, if you just want to plonk your money away … either as a one-off (Uncle Harry left you some money) or on a more regular basis (you have a 401k or just want to regularly save) … AND you have a 20+ year outlook, then this is where ETF’s or Index Funds finally come into play! Plonking your money into a Spider ETF or broad-based Index Fund can be better options than CD’s or Bonds. Just don’t get fancy here … the good news is that Warren Buffett also recommends this strategy for the “know nothing investor” as he calls them … he also calls it “dumb money“, but he means that in a nice way 🙂

Finally, I was a little amused this little ‘teaser’ on the very same page as this very nice Tycoon Report article exhorting you to ‘invest’ in ETF’s; it said:

Most ETF Traders Will Lose … And Lose BIG

ETFs are the hottest new investment around, and for good reason. But many everyday investors who jump into ETFs without a proven system to guide them will lose their shirts.

Then [of course] it went on to the ‘solution’: On Thursday, June 12th, Teeka Tiwari will reveal the secrets of using ETFs to generate enormous wealth. But, there’s nothing wrong with a little good marketing …

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